As the oil price slides, and Russia teeters on the brink, what will the year ahead bring for investors? John Stepek chairs our Roundtable.
John Stepek: Let’s start with the biggest news of 2014 – the oil price crash. Nobody saw that coming.
Max King: Quite right – I thought it would be a flat year for oil. In the short term, everyone is worried about the energy sector being downgraded.
But we know from history that a rising oil price is unequivocally bad for economies and markets, and a falling oil price is good for them. Even if oil goes back to $85 a barrel or so, that’s still a pretty significant plus for the global economy.
Steve Russell: I didn’t see it coming. But I should have, because I’m getting more and more interested by what I see as the perverse, weird effects of zero interest rates. Oil is a nice example. When you get zero rates, investors need income, so they shove money at companies to try and get them to do stuff.
In this case, zero rates have driven investors to lend too much to oil producers, who have overproduced and created a glut. That brings down the oil price, which is disinflationary, which in turn allows zero rates to be maintained.
So for once I think the low oil price is not a good news sign for markets or for the economy – I think it’s part of the poison of zero rates, which seems to be creeping through every sector in the market. Low rates produce over-investment and oversupply, which drives prices lower. And this is why interest rates can’t stay low forever.
There has to be an inflationary denouement. Why? Because low rates carry their own doom – and I think it might be that eventually zero rates bring massive deflation into the system, which central banks then counter with whatever extreme monetary policy it takes.
John: Causing a currency collapse.
Tim Price: We’re not just seeing deflation in oil – it’s also arguably in gold, and pretty much all of the fixed-income markets. I think it’s going to be the single biggest concern for next year.
John: Is this like sub-prime – where something nasty kicks off, perhaps in energy-sector junk bonds – then spreads?
Tim: A lot of people are comparing it to 1998, when Russia defaulted. I cannot believe there is not at least one major financial player in a state of distress and looking for official help by now.
Marcus Ashworth: Well, I actually think the falling oil price is good news. Sure, the whole thing has come apart extraordinarily quickly, so anyone who’s leveraged is in trouble. I agree with Tim that we’ll get a clear out of overstretched speculative positions. But overall this is extremely healthy.
Everyone’s worried about capital expenditure falling through the floor (as investment by oil companies dries up). That’s rubbish as far as I’m concerned. Yes, some oil-dependent economies will suffer. But on the upside, central banks probably won’t be in a hurry to raise rates, because inflation is going through the floor.
And deflation doesn’t have to be a bad thing – Europe, in theory the most important economy in the world by GDP, really needs this shot in the arm. Likewise Japan – the third-biggest – needs this because it shut down all its nuclear reactors. The net effect is that this should be the best thing the world’s ever seen.
Jim Mellon: I agree with elements of that, although I’m more in Steve’s camp. But there are other factors at play too. Energy intensity is falling around the world.
Max: Yes, some cars are getting 100 miles to a gallon these days.
Marcus: Yes, but you’ve got the Chinese middle class coming through, which is going to be a big boost to demand.
Jim: Actually, China’s energy intensity has improved by 25% in the last decade – and, of course, its economy is not doing as well as they say. But the real problem with oil is the credit problem. We know that Russia’s got $600bn of debt, much of which needs to be refinanced over the next year or so.
How is that going to happen, when the debt is in dollars and the receipts are in roubles? I lost a ton of money in Russia in 1998, having made a lot in 1997. This reminds me of that. And Russia is a much bigger player now – the effects of it going bust or having problems will be much greater.
So I wouldn’t say this energy slump is necessarily good – it’s more symptomatic of larger problems. You’re seeing it everywhere. Take iron ore – the price has just about halved. Why is this happening? Is it all efficiency, or is it because China has really, really, slowed?
Max: The way I see it, the story is quite simple. Banks have been permanently constrained from lending money by regulators, governments, and supply and demand. Credit growth is structurally low. So money supply growth is low too, and the velocity of circulation is going down.
The government compensates by doing quantitative easing (QE). QE is a free ride. It compensates for the fall in money being created by the private sector. It uses that money to buy back government debt. So the UK’s debt-to-GDP ratio isn’t 80% – it’s more like 50%, if you ignore the bonds owned by the Bank of England.
Those bonds will never have to be resold. So we’re locked into a world of slow and steady growth. That’s much better than the constant boom and bust of a credit cycle. It’s a great environment to invest in.
John: Growth might be slow, but market moves haven’t been – US stocks are the most overvalued since the last crash.
Max: The American market’s not overvalued – it’s reassuringly expensive. You pay a premium for quality, and you’re investing in the US dollar, which is only going one way – up.
Jim: That depends on the currency. When the yen was getting stronger, everyone was forecasting it would go to 50 against the dollar – it turned around before it got anywhere near. Now they’re all forecasting 150 or 250. So my general view is that Japan’s currency, at around 120, is now fairly valued, or even cheap.
But even if the yen stays where it is, the real argument for buying Japan is that corporate profits are really coming through, and the market is much cheaper than the US. The yield differential for Mr and Mrs Mikimoto between Honda or Toyota dividends and government bonds yielding 0.3% is now very attractive.
John: Are you still keen on Japan, Steve?
Steve: Yes. I’d still hedge the yen, just in case. But the government is now in power for another four years. I’ve no idea whether or not they really will get reflation and inflation – but for an investor it doesn’t matter, because they’re going to throw the kitchen sink at it.
On top of that, the companies are super. They’re making margins of 1%, compared to US companies making 10%. So the operational gearing is just magic. They’re not going to raise profits by 10% or 20% – they could raise them by 100% over a few years.
John: So we all like Japan. What about Europe? QE hasn’t happened. Will it ever?
Max: QE is a classic case of pushing on a string in Europe – it’d probably be good for financial markets, but it’s not going to do anything for Europe’s economy.
For QE to work, you have to get the money into the private sector. If QE happens in Europe, all you’ll get is the European Central Bank (ECB) buying bonds from European banks, who’ll then put that back into deposits with the ECB.
None of this is to say you can’t make money in eurozone equities. There are plenty of good companies listed there, with businesses around the world. But QE is not going to help. The eurozone is locked into long-term stagnation.
Jim: I agree. But will it remain intact, because Greek bonds are indicating that it won’t?
Max: Consider Italy. It was united in 1860. North Italy was poorer than the south, but over the years the south stagnated and the north got prosperous. You’ve had fatalism, stagnation and emigration from southern Italy – but 150 years on, the country is still together. The eurozone could do the same – hold together and just get poorer and poorer.
Jim: I disagree – you’ve got 25% youth unemployment, and in Italy and Spain it’s still 40%-odd – these are lost generations.
Max: People will emigrate.
Jim: But they don’t – labour mobility is terrible. Some of them come to London and Germany, but a lot are still stuck at home doing nothing.
Max: I’m not disagreeing, I’m saying that there’s an assumption that the eurozone will break up. But countries can wallow in stagnation for a long time. It’s a possibility that has been under-appreciated.
Jim: The euro is a one-way downwards bet. If it carries on stagnating, the only relief mechanism is to push the euro down, using QE. If they don’t do it, the danger is it’ll break up – and that’ll be bad for the euro too.
Marcus: The trouble is, Germany has got itself into a situation where it’s over-exported and beggared manufacturing industries throughout the rest of Europe. It’s now owed a lot of money by the other eurozone countries, which means a break-up would be a huge problem.
So Europe will stick together – because it knows nothing else. It’ll end up like Japan – it will ossify and protect what it sees as its interests, and beggar itself for decades to come.
Tim: I remember meeting a Japanese fund manager in 2000 or 2001. He said Japan was a dress rehearsal, the rest of the world will be the main event. That seemed ridiculous 14 years ago. It doesn’t now.
Europe desperately needs proper restructuring – if you had politicians willing to do brave and sensible things, you wouldn’t need QE. But they’re all asleep at the wheel. So the QE fixation is a sign of complete policy failure by modern politicians – it’s a disaster in the making.
Steve: Yes, but there’s something people are missing here. If you get the Japanification of the eurozone, the euro will strengthen dramatically, because that means lower and lower inflation rates – in fact, Europe may already have outright deflation. Even with zero rates, that means positive real interest rates. That’s what pushed the yen up for years. So we could in fact see a very strong euro next year.
Jim: Yes, but unlike the Japanese, the Europeans realise that a strong euro is really bad for them. They will find a way to engineer it down. They can intervene in the foreign-exchange market.
Steve: They also have the authority to buy overseas bonds. But that would be an outright declaration of currency war. Would the Americans stomach that? I wonder how long the Americans will accept having a strong currency – particularly if growth falters.
Tim: But do you think Europe is the issue for America, or rather the Far Eastern currencies?
Steve: Europe. The rest are dollar block countries, apart from Japan, which isn’t that big relative to Europe. And the Japanese have stolen the march – I don’t think Europe can catch up with Japan in devaluing. It would love to – but I don’t think they’ll both be allowed to devalue that much in such a short space of time.
Jim: One thing the zero-interest environment is doing is accelerating technological change. In an era of capital abundance like this, machines make more machines, and become much more efficient than human beings. That’s why you’re seeing all these books, such as my own, on human redundancy.
John: Presumably this is a positive thing?
Jim: In some ways.
Tim: But it’s terrifying for the unskilled. It’s terrifying for the people who are going to be deprived of education because the system can’t afford it any more.
John: So how do we cope with that?
Jim: I don’t know. It’s not that bad for advanced societies because we have an ageing population and automation works in our favour. But the old emerging-market development model – where you move off the farm to work in the factory that made the cheap clothes to send to Top Shop and so forth – is broken, because manufacturing is now much more efficient at the point of consumption.
For instance, I don’t know how Africa will generate the growth required to sustain its population. Africa has one billion people today and is expected to have 4.5 billion by 2100. That’s frightening. Half of all the children in the world by 2100 will be in Africa. Where do they get the jobs?
Marcus: The human mind is an incredible thing. Africa, and particularly places like Nigeria, will find a way round this. There’s plenty of south to south trade – this is not just about developed markets trading with emerging ones. For example, China wants to do more business with Africa and Brazil to spread its exposure away from the Western world.
John: Are there any emerging markets you’d buy now?
Max: Latin America. As Marcus says, it’s not about the mercantilist idea of trading with developed markets, it’s about growth and consumption across emerging markets. Latin America has underperformed Asia in the last year and Brazil is a bit of a mess. But I don’t think it’s going to get any worse.
There’s going to be regime change in Argentina, and probably Venezuela. Mexico is fine. So I’m not sure about 2015 – but if you buy now and leave it for a few years, you’ll be fine.
Steve: We’ve not liked emerging markets for many years, and as far as I can see, broadly we’ve been right. But the one we do like now is China. The government is desperate to get a proper savings market going – and it generally gets what it wants. So we think this 40% rise we’ve seen in the last three or four months in China is just the beginning.
I’ve seen statistics showing that if you put a tenth of the average amount gambled in Macau into the Shanghai Stock Exchange, it doubles over the next period. I think that might happen. China appears to be able to shove problems with its banks under the carpet for another couple of years. So that’s the one emerging market we like at the moment.
John: Does anyone think the commodities sector will turn around, or is there now another long period of decline in real commodity prices before the next boom?
Jim: You can buy Rio Tinto (LSE: RIO) and BHP Billiton (LSE: BLT) for the long run. They’re the low-cost producers. They’re very cash generative, even at current prices. They’re cutting costs and becoming more efficient – using driverless trucks in Australia, for example. The declining Australian dollar helps boost margins too, because they get their revenue in US dollars.
Steve: You wouldn’t want to make a call on when the pain in the commodity markets will stop. It could easily last much longer. But in the long run, I love the Canadian oil sands businesses. They need higher oil prices to survive, but they are beautifully geared into high prices when they appear.
The exploration risk is zero, because they know exactly where the oil is – it just costs “x” amount to extract it. So if the oil price is $60, they’re breaking even. If it’s $70, they make money.
John: Would you buy now though?
Max: Yes, why not?
John: Well, oil might fall another $20.
John: The big call this year was that bonds would definitely lose value. Instead, they’ve gone up.
Max: People missed two fundamental realities about bonds. One is that inflation is falling, so real yields are still positive. Secondly, if you’re an Italian car worker or a Spanish dentist, where do you put your savings? Your bank could go bust.
You don’t want your own government’s bonds, because they might leave Europe. So you want your money in Germany. The easiest way to do that is to buy German bunds, rather than going to Germany and opening a bank account. But it’s coming to the end of the game now. I prefer equities for next year.
John: What about gold?
Tim: Gold’s actually up in every currency this year – including the dollar.
Steve: Gold is getting interesting. There’s a consensus that the dollar will strengthen – it probably will a bit. But what happens when that runs out? If the dollar isn’t strong, what’s left? I think gold would be the beneficiary of that shift. So we’re hanging on to about 4.5% in our fund.
Marcus: Yes, why on earth would you sell gold here?
John: Britain’s got a messy election coming up too – any thoughts?
Max: It’ll be okay.
Steve: All outcomes look absolutely disastrous, but we’re generally quite a sensible country. We look at ourselves and go: “Oh, it’s awful”. Foreigners look at us and go: “Please can I have a house here” because we’ve got rule of law, we’ve got stability.
John: OK. What about individual tips?
Jim: My first stock is Genfit (Paris: GNFT). There is a disease called NASH – fatty liver disease, basically – that is likely to affect about half of all Americans in the next ten years. It tends to go alongside obesity and diabetes and so on. An American company called Intercept, which works in the field, was one of the best-performing stocks this year – it went to a $10bn valuation.
Genfit trades at a fraction of that price – $1bn – and I think its drug is better. It’s an oral drug, in late Phase-II trials, which has the potential not only to deal with fibrosis, sclerosis and NASH itself, but also to reverse the diabetes the disease can cause.
My second tip is Hewlett-Packard (NYSE: HPQ), which is splitting into two. The printing and consumer business will be one company, and the enterprise business the other.
Both make roughly the same revenue, but the printer business is being loaded up with the debt, while the enterprise business is being given the chance to grow. This business is involved in something exciting called Memristor technology, which allows a huge increase in memory capacity.
For example, you could have your iPhone on, recording every second of every single minute of every day of your life, and it would still have capacity to spare. Hewlett-Packard is the leader in this, and it trades on less than ten times earnings, and it’s not highly indebted. It’s a dinosaur – but it may just be about to come back.
As for my third pick – I just bought an oil company called Ophir Energy (LSE: OPHR). It makes quite a lot of money, even at the current oil price.
It’s got $1.5bn in cash because it sold an African concession recently, yet it’s only got a $1bn market cap, so it’s currently selling for just two-thirds of its cash value, and it’s got no debt – so I like that.
John: What’s your short of the year? What would you avoid?
Jim: LinkedIn (NYSE: LNKD). Have you ever been afflicted by LinkedIn sending you emails every day?
John: Yes. It’s very annoying.
Jim: Very annoying and the website is incomprehensible, it’s so clunky.
Steve: I agree. The purpose of LinkedIn is for professional contacts, isn’t it?
Jim: Recruiters, yes.
Steve: Well, the company I work for blocks social media sites. I can’t use it.
So what’s the point of LinkedIn?
Marcus: I think LinkedIn is an appalling company.
Jim: Well, we’re all agreed – yet it trades on 100 time earnings. So that’s my short.
Marcus: My short is the whole bond market. And I’d single out German bunds in particular. The only reason bund yields are so low (and prices high) is because everyone believes Europe is going to break up. So – the thinking goes – the only thing to be in is bunds.
But in fact, you don’t really want German debt, because if Europe does break up, Germany’s going to end up being owed a load of money by other European countries, which may never be repaid. And if everyone stays together, then the risk aversion that has encouraged people to rush into German bunds at these low yields will rapidly dissipate. So one way or another, they have to go higher.
John: What about your buys?
Marcus: In the UK, you could look at Balfour Beatty (LSE: BBY). The current government wants to build everywhere. They’re paving over the southeast. I loathe what they’re doing to our country, but it’s not going to go away. So with decent management in place, Balfour Beatty should see some serious upside from all this talk of building more infrastructure.
Another interesting stock to watch out for is Steinhoff (SJ: SHF). It’s currently listed in South Africa. It’s one of the world’s largest furniture retailers and a potential rival to IKEA. It currently trades on a price/earnings (p/e) ratio of ten, but will list in Frankfurt next year, which should see it re-rated higher. So get in early on that one.
And a third one is Spanish media company Mediaset Espana (Spain: TL5). TV advertising has been stronger than expected this year, and we expect that to continue into 2015, which should be good news for this sector.
John: What are your thoughts, Tim?
Tim: We think that gold will turn around in 2015. Fresnillo (LSE: FRES) is our preferred way of playing that. It’s the largest primary silver mine in the world, but it’s also backed broadly with the revenues from gold. Like everyone else, we like Japan – on a currency-hedged basis – so we’d go with the Neptune Japan Opportunities fund.
I also think there’s a danger of being a bit overly sanguine about prospects for markets next year, so we want to diversify by using a trend-following fund. This strategy has been out of favour for a while, but had a great year this year, and I think the best is yet to come. So we’d go with the BlueCrest Bluetrend Fund (LSE: BBTS).
As for my short trade, I think there’s a danger of being overly optimistic about the UK next year, so my short would be sterling, against the US dollar. Whether we end up with a rainbow coalition or an outright majority, the austerity starts for real next year.
Steve: I’m going to go with Japan again, so I’d suggest Hitachi (JP: 6501). It’s been getting rid of its loss-making bits – you can’t buy a Hitachi TV anymore, which is good, because they never made money on them. They’re big in transportation and nuclear power too. In the UK, I think Marcus is right on the building boom, so I’d go for Crest Nicholson (LSE: CRST).
It’s got a big land bank and if the house builders do stupid things, such as buying each other, then they’ll buy Crest Nicholson. A high-risk play on Russia is property group Raven Russia (LSE: RUS). I think it’ll survive, so it’s a matter of waiting out the tough times.
Marcus: You’ve got to buy Russia at some point in the next year – it’s the cheapest market of all and it will correct.
Steve: But at the moment it’s a bet, not an investment. The other one I like is Boeing (NYSE: BA). The airlines will get this great big boom from the oil price, and they will spend that money on buying new aircraft.
The other thing is that Boeing went down this week on the Airbus A380 announcement that it’s no good and nobody wants it. But if nobody wants the Airbus A380, they will have to go to Boeing for alternatives.
As for my short, I’d sell so-called safe high-income stocks. If I had to pick one, I’d go for Royal Mail (LSE: RMG). I don’t know enough about it, but there’s enough competition going on there in what is supposed to be a growth area.
Max: I like Disney (NYSE: DIS). It’s opening a new theme park in Pudong, Shanghai. Disney is not big in China yet, but I think its growth will accelerate after this. It’s not going to make you a fortune, but it’s a sound long-term investment. On my second stock, I don’t generally like big pharma, but Bristol-Myers Squibb (NYSE: BMY) has some very interesting immunotherapies for cancer.
Max: You know how well IT stocks do if an iPhone or whatever takes off. I’ve seen charts of the sales of Gilead’s hepatitis treatment, Sovaldi – put it this way, if a drug works, it makes the take-up of products like Apple’s iPad look pedestrian.
For my third, I can’t resist an oil play. Oil to me is really all about increasing efficiency and productivity. Schlumberger (NYSE: SLB) helps oil companies to cut costs and improve efficiency. It’s a blue chip in oil services. Its main rivals, Halliburton and Baker Hughes, have recently merged – and when you’ve got a trio of dominant companies and two merge, the third one usually picks up a lot of free business.
As for my short idea – I’m going to turn to political betting. For the next election, I’ll short Labour and Ukip seats. Labour has won ten elections in its history, but it’s never won anelection from the left, and I don’t think it will this time either.
And I’m short Ukip because I think it’s a party for losers. It’ll probably get about 10% of the votes and Douglas Fairbanks Jnr or whatever his name is will keep his seat, but I think that’s about it.
Jim: I’ll take a bet on that with you. You think they’ll get one seat, I think they’ll get about ten. Whoever’s farthest away buys lunch!
Max: You’re on!